Last night, Apple blew away numbers. Perhaps now would be an appropriate time to establish the first quarter or half of a short position. With my negative long-term outlook on Apple based primarily on investors underestimating the competition factor as well as other qualitative reasoning, I went on to compute a fair value for Apple based on a discounted cash flow analysis. Getting right to the point, my fair value of Apple is approximately $156.00/share. This is roughly a 40% correction from its intraday price of $258.00/share.
What led me to my fair value? I'll go through my calculations step by step. First off, all of the projections range out to 2019. The data has also been adjusted for the adoption of new accounting principles for the relevant time periods. With all items on an annual basis, I will begin with net sales. I assumed a constant 15% net sales growth rate. I did not assume more or less growth for further out years, just a steady 15%. To put this growth rate in perspective, Apple will have $102 billion in sales by 2014. With a growth rate of 25%, by 2014, Apple's annual sales would be about $142.5 billion - that is 2 times Microsoft's 2008 annual revenue and just under 2 times Procter and Gamble's 2007 annual revenue. I do not see that potential especially if unemployment remains high and there is minimal income growth - also keep in mind that Apple products are elastic, meaning the demand for Apple products can change significantly based on several things such as price and substitutes, or what I refer to as competition.
Moving forward, I projected that cost of sales would grow at a near 13.48% which I feel is accurate considering that cost of sales had an average growth rate of 26.97% from 2007 to 2009. R&D, a very important aspect to Apple considering that they are innovators, for my model had 31.01% annual growth. This growth rate was the average from 2007 to 2009. What I intend on doing in the future is comparing R&D growth of Apple to other companies. I will be searching for companies whose R&D is growing at a faster rate than Apple's. When I do find companies whose R&D is growing faster than Apple's, Apple shareholders should become somewhat concerned unless Apple plans on issuing a dividend at some point in the near future. I gave a 23.63% growth rate to selling, general, and admin. expenses. From 2007 to 2009, SGA expenses grew on average, 18.63%. I added a 5% premium to account for new store openings and more store employees.
Capital expenditure, depreciation, current assets, and current liabilities were assigned 2.5%, 49.83%, 5.16%, and 1.28% growth, respectively. For the expected market return, I assumed about 10%, a 1.5 beta, 14.47% for the weighted average cost of capital, and 4% terminal growth. Keep in mind that for WACC, Apple has no debt. A fantastic finance professor of mine always argued that a firm with no debt is not maximizing their enterprise value. Even during the economic turmoil, we saw Microsoft tap the debt markets because it was so cheap to do so! Lastly, a corporate tax rate of 35% seemed accurate. Anyone who has questions regarding my calculations, post your thoughts and I will respond accordingly. So there you have it, $156.00/share. Now I will be straightforward, I do not have a 25 tab excel DCF monster with complex detail that intertwines thousands of cells to spit back a per share value.
On the previous post, I stated how Apple has soared from $80.00/share to its current levels. Excuse me for the correction, but Apple really traded in the mid-100s prior to the crash. So on a percent basis, Apple did not rally as much when looking at a 2 year chart, but that still does not excuse the potential fact that competition can do a number on Apple. In addition, I noticed how Apple's net sales were actually down 14% when compared to fiscal 2010 Q1 net sales. I do realize that during the holiday season, companies generally report stronger earnings. However, I decided to do some more digging... Going back to 1994/95 and comparing Apple's 2nd quarters (Jan-Mar) to its 1st quarters (Oct-Dec), on average, 2nd quarters have declined by 10.75%, which again, is due to the holiday season. 18.75% of the time, 2nd quarters have had positive sales growth compared to 1st quarters. If Apple products today are the best ever, I wonder why we did not see positive sales growth. Holiday season might be strong, but during 2009's holiday season, unemployment was jacked. Apple also had crushed estimates now for the past 21 consecutive quarters, so I personally would have expected at least positive sales growth for Apple in Q2 2010 from Q1 2010, at least a number greater than the negative 10.75%. I understand that the product cycle plays a fine role here, such as when certain products are released, nonetheless, Apple has rapidly come out with interesting devices... I simply cannot see how there is still so much room for the company to run.
I wonder why so many analysts seem to overlook competition when it comes to Apple. Look back less than 10 years ago to PALM’s rise to fame after the dot com bubble burst. PALM stock climbed and traded above $500.00/share for some time. The PDAs were strong and dominated the consumer market. PALM today is just under $5.00/share. Of course everyone says Apple is different and there is a crazy new technology era underway, which yes, might be the case. But when competition is not factored enough into financial models, you get inflated stock prices – and we know where the story goes from there.
Full disclosure: Currently do not have any positions in the companies discussed.
